Loan Agreement

What is a Loan Agreement?

A Loan Agreement is a written promise from a lender to loan money to someone in exchange for the borrower's promise to repay the money lent as described by the Agreement. Its primary function is to serve as written evidence of the amount of debt and the terms under which it will be repaid, including the rate of interest (if any). The Loan Agreement serves as a legal document that is enforceable in court, creating obligations on the part of both the borrower and the lender.

The Loan Agreement can be used to record the terms and conditions of a loan made between individual persons or companies who are Indian citizens. Loans by a foreign lender to an Indian borrower are covered under different rules and regulations made thereunder, and this document has not been adapted to be used for a loan by a foreign lender to an Indian company/individual.

When lending money to a friend or family member, or engaging in a commercial loan between two businesses for a specific purpose, various options are available in the Loan Agreement. The Loan Agreement can be used for a simple interest-free loan or include automatic interest calculation. Additionally, there is flexibility to establish a repayment schedule, include guarantors, and demand that the borrower provide collateral for the loan.

It may be noted here that in India, there are laws that regulate money lending and a person/entity in the business of making loans would need to be registered as a moneylender or with the Reserve Bank of India as a banking company or a non-banking financial company.

Is it mandatory to have a Loan Agreement?

Yes, in most situations where property is used as collateral, it is necessary to have a written loan agreement. However, it's better to have a written loan agreement in all cases. Including all major clauses will help the lender and the borrower establish their relationship and seek legal protection in case of a dispute.

What does the "Collateral or Security of Loan" mean?

A collateral or security for a loan refers to the immovable or movable property attached to the loan as security. In case, the borrower fails to repay the loan amount, the Lender can attach and sell the collateral to recover the outstanding loan amount. Following are some of the collateral or security of a loan:

• Land and other immovable property - There are some additional formalities to be complied with if the loan is secured by a charge over a property i.e. in case of a default in repayment of the loan the lender would be entitled to sell the property and recover the loan amount, interest, and other amounts payable by the borrower.
• Movable property such as assets, machinery etc. – Security over movable property can be created by way of hypothecation and execution of a deed of hypothecation.
• Pledge over shares and other movable assets – Another type of security that is often provided is the creation of charge on financial instruments such as shares of a company.

What does a "guarantor" mean?

A guarantor is someone who promises to pay the borrowed amount if the borrower defaults, ensuring the lender's security and the repayment of the loan.

What must a Loan Agreement contain?

The Loan Agreement must include the following clauses:

• Parties involved: the name and details of the lender, borrower, guarantor, etc.
• Loan amount: the total sum of money borrowed.
• Interest rate: The type of interest such as simple interest or compound interest and rate of interest.
• Repayment schedule: defines the frequency and amount of loan repayments.
• Late payment charges: penalties or charges on delayed payment by the borrower.
• Prepayment clause: conditions of paying off the loan early by the borrower.
• Collateral details: description of any collateral pledged for the loan.

What is not allowed in a Loan Agreement?

The Loan Agreement should not contain any clauses that have unfair terms, excessively high interest rates, or conditions that could negatively impact the legal rights of the borrower including restricting the borrower from repaying the loan amount before the due date, changing the terms by the lender without the consent of the borrower, appointment of the arbitrator solely by one party, etc.

Who can enter into a Loan Agreement?

Any individual (18 years or older) or legal entity in India not prohibited by law can enter a Loan Agreement. Only Indian citizens can enter into this Loan Agreement. An Indian citizen is an individual who is legally recognized as a member of the Republic of India. This status is primarily obtained by birth, descent, registration, or naturalization as outlined in the Indian laws. An entity can also be considered an Indian citizen if it is a corporate body incorporated or registered in India.

What can be the duration of a Loan Agreement?

The duration of a Loan Agreement can vary significantly based on the type of loan and the lender's policies. It can range from a few days for overdrafts to many years for home loans.

What has to be done once the Loan Agreement is ready?

The Loan Agreement will be legally binding when it has been printed on non-judicial stamp paper or e-stamp paper, and signed by each party. The value of the stamp paper would depend on the state in which it is executed. Each state in India has provisions in respect of the amount of stamp duty payable on such agreements. Information regarding the stamp duty payable can be found on the State government websites.

Each Party should sign and return a copy of the Loan Agreement. Where a company is a party to this agreement, they should ensure that the Loan Agreement is signed by an authorized signatory, which is usually a director as authorized by a board resolution of the company.

Where the Lender has requested that the borrower provide a guarantor, such guarantor should also carefully read the entire Loan Agreement and its guarantee obligations, and sign where indicated.

Each Party should keep a signed copy of the Loan Agreement. To do this, two different copies can be signed (or three if there is a guarantor as well), or if only one copy is signed, it can be photocopied and then distributed between the parties.

Which documents should be attached to a Loan Agreement?

The following documents shall be attached to a Loan Agreement:

• Proof of identity of the parties involved in the Loan Agreement such as Aadhaar, GST certificate, etc.
• Income proof of the borrower including salary slips, income tax statements, bank statements, etc.
• Collateral documents like property papers, vehicle registration certificates, etc.

Is it necessary to register the Loan Agreement?

Yes, The necessity of the registration of the Loan Agreement is as per the nature of the Loan Agreement. Security over real assets i.e. immovable property is created by way of a mortgage. A mortgage (other than an equitable mortgage) for repayment of more than INR100 must be by way of a registered instrument (indenture of a mortgage). A mortgage of immovable property (other than an equitable mortgage) must be registered within 4 months. The Loan Agreement needs to be registered at the office of the Sub-registrar where the collateral property is located or where any of the parties to the agreement resides.

Certain security interests must also be registered with the Central Registry of Securitization Asset Reconstruction and Security Interest of India (CERSAI). In some cases, prior permission is required to be obtained from the income tax authorities to create charges on immovable properties.

In case of a charge being created by a company over property or instruments such as its shares, the filing must be made with the Registrar of Companies, regarding the creation of the charge.

How does the security or collateral work in a Loan Agreement?

Collateral works as security or protection to the Lender in case the borrower refuses to pay the outstanding loan amount. In case, even after sending a demand letter, the borrower refuses to make the loan payment as per the Loan Agreement, the lender can initiate legal proceedings to seize or attach the collateral.

The borrower can then sell the collateral through public auction or other means and if any balance is due after such sale, the borrower will be liable for such balance amount.

Which laws are applicable to a Loan Agreement?

This agreement is subject to the broad principles of the Indian Contract Act, 1872.

The Companies Act, 2013 regulates the giving of loans, guarantees, or security by companies to their directors (whether directly or indirectly).

Banks are required to comply with directions issued by the Reserve Bank of India regarding interest rates that can be charged by them.

If the Loan Agreement is between an Indian citizen and a foreign person the rules and regulations of the Foreign Exchange Management Act, 1999 will apply.

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